Investors Need to Be Selective in Following the Fed

With the Federal Reserve’s “whatever it takes” measures succeeding in reducing the threat of financial market failures, investors are inclined to “follow the Fed” by purchasing riskier securities to take advantage of prices not seen for quite a while. It’s an investment approach that has worked well in recent years in virtually all asset classes. Although it is likely to work again, it will be in far fewer market segments and subject to greater uncertainty and risks, especially in the lower parts of the capital structure of companies and the economy as a whole.

The strongest argument for an investment approach that focuses overwhelmingly on a single issue — how committed, in words and actions, is the Fed to financial market stability — is that this worked extremely well for many years. Again and again, the world’s most powerful central banks jumped to repress higher market volatility. Again and again, they succeeded. And again and again, this contributed to continual across-the-board gains. With that, investors were conditioned to “buy the dip,” resulting in periods of exceptional gains, low volatility and unusual correlations in which the prices of both risk and risk-free assets rose together.